Foreclosure Nation

Mortgaging the American Dream

Shari B. Olefson, JD, LLM

Attempts at Relief and Reform

Federal regulators propose 20% down payment for best home mortgages

Posted on Monday, April 4, 2011

If you want to buy a $300,000 house, you’ll need $60,000 as a down payment to get the best interest rate on your home loan, according to a proposal released Tuesday by federal regulators.A group of federal agencies announced a high standard for home buyers to get the best mortgage rates: Only those who can make a 20 percent down payment and have not had problems paying mortgages in the recent past would be eligible.The regulators are trying to prevent the kinds of practices that dumped so many risky mortgages into the financial system several years ago. But the proposal has sparked concerns from some groups, which worry that a 20 percent down payment is too onerous for many working-class borrowers. Banks also oppose the heightened down-payment requirement, which regulators had considered setting as low as 10 percent.The proposal, which could be made official this summer, is unlikely to make a major difference in the market for a while, because most home loans are insured by federal agencies using taxpayer dollars. Those mortgages would be exempt from the proposed requirements.The regulatory effort comes as the Obama administration and House Republicans have made proposals to begin winding down Fannie Mae and Freddie Mac, the government-backed mortgage giants, in part by reducing the competitive advantages they have over banks. This could include requiring that the two mortgage firms begin charging higher fees. The aim would be to draw private firms back into the mortgage market, which they exited during the financial crisis.In the years leading up to the financial crisis, lenders could hand off loans — many of them high risk — to other companies for a fee. Without skin in the game, they could continue to make risky loans.Officials say the new rules would correct that. “Properly aligned economic incentives are the best check against lax underwriting,” said Sheila C. Bair, chairman of the Federal Deposit Insurance Corp., which announced the beginning of the public comment period on the proposed rules.The new standard was proposed by the FDIC and the Federal Reserve. Other regulators are expected to follow suit. The rule, known as “risk retention,” would require that mortgage lenders invest in the loans they make, so if the loans go bad, the lender would suffer. Lenders would have to accept 5 percent of the losses. But banks would not have to retain any risk for mortgages made to borrowers who put down at least 20 percent — making the loans relatively safer. As a result, the cost to the banks would be less, and they would be able to offer lower interest rates for these loans.Some critics say these conditions would keep eligible borrowers from getting good terms on their loans.“If we require 20 percent down payments to get a loan, we will ensure broad swaths of working- and middle-class people will not be able to get a loan,” said John Taylor, chief executive of the National Community Reinvestment Coalition, a group advocating an extension of credit to low- and moderate-income borrowers.Wall Street executives say the proposal would make it difficult to lure banks and private firms back into mortgage lending without taxpayer guarantees. Tom Deutsch, executive director of the Wall Street trade group American Securitization Forum, said the 20 percent requirement would dissuade banks from making any loans that are not backed by taxpayers.“The extremely rigid proposals . . . will further prolong the U.S. government’s 95 percent market share of the credit risk of newly originated mortgages,” Deutsch said.Bair said she is looking for additional comment on the down-payment requirement as the comment period begins. The FDIC is expected to vote on the proposals in late spring or summer.Treasury Secretary Timothy F. Geithner, who spearheaded the regulatory effort, applauded the proposal.“Risk retention will help promote better standards for underwriting and securitizing mortgages, which is good for the long-term health of the housing market and for our nation’s economy,” he said.The regulators acted on the same day that House Republicans announced their vision for overhauling the nation’s mortgage system, a month and a half after the Obama administration had revealed its plan to wind down Fannie and Freddie.The GOP bills would raise borrower fees in two years, require Fannie and Freddie to begin selling their massive portfolios of mortgage investments, which ensure a steady supply of funding for mortgages, and take away other advantages that banks and other private firms do not have.The measures would also formally end requirements that Fannie and Freddie direct a portion of their business to low- and moderate-income housing and pay their employees the same as their counterparts in the federal government earn.Rep. Spencer Bachus (R-Ala.), chairman of the House Financial Services Committee, said the measures are intended “to create a well-functioning, private, competitive secondary mortgage market to price mortgages according to risk, be more innovative and efficient, and operate with less political interference.”Neither the Obama administration nor the congressional Republicans have endorsed a long-term approach for replacing Fannie and Freddie.By Zachary A. Goldfarb, THE WASHINGTON POST